Summary: In this article, we will share our top 11 reasons to pay cash for rental property and why. We will also discuss potential risks of paying cash for rental property, investment strategies to minimize these risks and helpful resources on related topics.
- Why You Should Pay Cash for Rental Property
- Risks of Paying Cash for Rental Property
Oh, the long-debated argument for reasons to pay cash for rental property versus leveraging. The reality is, there are a ton of valid points for and against paying cash and for and against financing an investment property. I am not going to answer the cash vs leveraging question in this article. This is largely because there’s no blueprint for successful real estate investing.
Every investor’s financial situation and goals are unique. Which is why in today’s article we will focus on answering the question, should I buy a rental property with cash?
Why You Should Pay Cash for Rental Property
In the following sections, I will share 11 reasons to pay cash for rental property, according to our team of experts at RealWealth. We hope you find the following information helpful.
1- Lower Closing Costs
One perk of buying a house outright with cash is that it cuts way down on closing costs. Paying cash for a rental property will avoid costs associated with getting a mortgage. You won’t have to pay lender fees, origination fees, mortgage insurance, title insurance and other fees associated with financing a rental property.
2- Higher Cash Flow
Buying an investment property in cash will undoubtedly produce higher cash flow. This is because you won’t be paying a mortgage on the property every month. A rental property purchased with cash should immediately start seeing cash flow as soon as a tenant moves in.
To determine your potential return on investment, calculate the Cash-on-Cash Return as this figure will be the most helpful in understanding the cash flow or return on the money you invest. This article explains exactly how to calculate a Cash-on-Cash Return for rental properties.
3- Quicker Buying Process
Another reason to pay cash for rental property is that it expedites the buying process. Cash investors can purchase faster rather than waiting on the mortgage process. A typical mortgage process can take anywhere from 30 to 45 days to close.
Additionally, you don’t have to worry about qualifying for a loan. Your credit score and income are irrelevant if you pay cash for rental property or a home.
4- No Debt
If given the choice between debt and no debt, it’s hard to imagine a single person choosing to have debt. Obviously it would be nice to be completely debt-free. And if you are, congratulations! You are one of a small percent. If you have the financial capacity to pay cash for a rental property, opt out of debt and start seeing monthly cash flow sooner.
5- No Interest Payments
As with any type of debt, taking out a mortgage comes at a price. Financing a rental property will result in paying interest on the borrowed money. Your interest rate will depend on your credit score, liquid assets, how much you put down and length of the loan.
Paying for a rental property in cash allows investors to completely sidestep the expense of interest payments, saving thousands of dollars. Although mortgage interest is tax deductible, it can greatly impact your cash flow. If your rental income is the same as your mortgage payment, you won’t be making anything on your investment.
Buying a rental property outright by paying cash gives you 100 percent equity of the homes value. We can’t talk about equity without also talking about appreciation. Real estate appreciation is how the value of an investment property increases with time. Appreciation is why we strongly encourage a buy-and-hold strategy in real estate investing.
Let’s use an easy example. You buy a rental property for $100,000 and see a $15,000 equity increase due to appreciation. That gives you 100 percent equity in a $115,000 property plus monthly cash flow from rental income.
7- Attractive to Sellers
Almost all of the time, sellers will take a cash offer over all other offers. Some sellers will even give a small discount if buyers pay cash, because it will help them avoid the financing process and close quickly. There’s also less risk of the deal falling through if the buyer doesn’t get approved for financing. Cash buyers simplify the process for both buyers and sellers.
8- Lower Monthly Expenses
Choosing to go the cash route to buy a rental property will hugely lower your monthly expenses. Of course you won’t be paying a mortgage, but you will also cut out loan interest, mortgage insurance (if necessary), and title insurance.
9- No Risk of Foreclosure
Paying cash for a rental property allows a real estate investor complete ownership of the property. Because you own the property outright, there is no risk of foreclosure or losing the property.
Yet another reason to pay cash for rental property is that it is less likely you will lose your entire investment. Even if the market takes a downturn, you still have 100 percent equity. And as with any market, the real estate market fluctuates. Once again, holding onto an investment property long-term is our favorite investment strategy.
10- Vacancies Aren’t as Scary
A constant concern for real estate investors is vacancy. When a property is left vacant the investor is losing money. Vacancies are less scary when a rental property is bought with cash because you don’t have to stress about rental income covering your upcoming mortgage payment. If a property purchased with cash is vacant, you aren’t going to lose as much.
11- More Control Over Property
Not being at the mercy of making monthly mortgage payments and interest will allow for more control over your investment property. Almost all of your rental income will be profit, minus related expenses like management and property taxes. All appreciation gains are tied directly to the property with no interest.
Risks of Paying Cash for Rental Property
Please keep in mind that every investment comes with risk. Buying rental property in cash requires a large amount of disposable income. Not only to purchase the property outright, but enough cash reserves in the back to maintain the rental. With that in mind, here are a few risks of paying cash for rental property and how to minimize them.
Less Diversification of Assets
Tying up all or most of your liquid assets in one investment can be risky. One of the hard-and-fast rules of investing is the principle of Diversification. In finance, diversification is the process of allocating capital in a way that reduces exposure to any one particular asset or risk. Reducing risk and volatility can be achieved by investing in a variety of assets.
Placing most of your liquid assets into one investment can be risky because that will limit your ability to diversify your investment portfolio. However, if you feel comfortable financially putting a large amount of money into a real estate investment, then go for it.
Fewer Tax Deductions
Depending on what tax bracket you are in, the mortgage interest deduction can save you a lot of money. Because you can write off a certain percentage of your mortgage interest, investors that choose to pay in cash won’t see the same tax deductions and advantages.
However, if you are in a lower tax bracket, some of these tax deductions are not as beneficial. For example, if you borrowed $200,000 at 4.5 percent, you will be paying almost $9,000 of interest in the first year. In the lower tax bracket you could deduct about $1,350, but that would mean you would still be paying around $7,650 in interest.
(Please note: these figures are estimates. I am not a tax expert.)
Less Liquid Assets
Pouring a good chunk of your liquid assets (cash) into one property may be considered risky, especially if you practice diversification in your investing. Another investment strategy, in an attempt to minimize risk (and diversify), is using the same amount of money to buy multiple properties with a mortgage. While you will be investing a large amount of money in real estate, your entire investment won’t be dependent on a single property. Rather, buying several properties through leveraging may appear to be less risky for some investors.
Whether you are looking for reasons to pay cash for rental property, researching different real estate investment strategies, or simply trying to expand on your investing knowledge, our team at RealWealth is here to help. We have an expansive library of free articles, resources, webinars and advice on real estate investing and all related topics.
For more information on buying a house in cash vs mortgage, check out one of my recent articles here.